Sun Microsystems Reports $1.7 Billion Loss and Falling Sales

Friday

Oct 31, 2008 at 12:01 AMNov 1, 2008 at 5:13 AM

Amid dismal sales and a massive charge, it’s clear that Sun is coming under pressure to do something radical.

ASHLEE VANCE

MOUNTAIN VIEW, Calif. — With falling revenue, problematic acquisitions, product slips and a stock that has lost three-quarters of its value in the last year, Sun Microsystems is finding that Wall Street is losing patience.

The company, which makes computer servers, reported dismal sales and a large write-off Thursday — but otherwise announced no changes in a strategy that has so far failed to restore the luster that Sun had during the dot-com era.

“Sun is a problem child, and the problem child has to change,” said Brent Bracelin, a hardware analyst for Pacific Crest Securities.

For its first quarter, ended Sept. 28, Sun reported a net loss of $1.68 billion, or $2.24 a share, compared to net income of $89 million, or 10 cents a share, in the same period last year. The loss includes a $1.45 billion charge to write down the value of past acquisitions and a $63 million restructuring charge.

The company’s revenue dropped 7 percent, to $2.99 billion, from $3.22 billion in last year’s first quarter. “Certainly, along with our customers, Sun is experiencing a slowdown as a result of the challenging economic climate,” Jonathan I. Schwartz, Sun’s chief executive, said during a conference call with investors. “There is a new reality in the marketplace.”

Revenue declined across the globe but was particularly bad in North America, where sales fell 20 percent among financial services customers.

Sun’s servers and Java software are the driving force behind many Web sites and business operations. But in recent years, Sun has struggled to adapt as customers gravitated away from its high-end machines that use custom software and processors to cheap computers powered by commodity parts and free, open-source software.

Sun’s bets on new server and storage systems, new processors and its own open-source software have not come through as fast as the company had hoped.

This month, the company’s top product developer and co-founder, Andreas von Bechtolsheim, left as chief architect to become chairman and chief development officer at a start-up company. And the global financial crisis is pounding the company as Wall Street and telecommunications customers, which make up an estimated 40 percent of Sun’s sales, have collapsed or curtailed technology spending.

Sun’s results were announced after the market close. Shares closed at $5.29 in regular trading Thursday, up nearly 10 percent, giving the company a market value of about $4 billion despite annual sales of about $14 billion. The low market capitalization, combined with Sun’s vast intellectual property portfolio and $2 billion in cash, suggest to some observers that Sun needs to do something drastic to bring out its shareholder value. Options include going private with the help of supportive investors or selling its old-line server business to its partner, Fujitsu.

Sun moved Thursday to placate Wall Street by disclosing more information than usual about its various product lines, showing strong growth with some of its more radical server designs and traditionally slow-selling storage products. It also hinted at impending layoffs.

It is unclear if that is enough to satisfy some of Sun’s largest investors. “They need to cut,” said Chris Whitmore, an analyst with Deutsche Bank.

Over the last few months, Southeastern Asset Management, a Memphis investment firm run by O. Mason Hawkins, has acquired more than 20 percent of the company. Southeastern has said it expects to actively engage in discussions with Sun’s management and third parties about the company’s future.

In a rare public comment, Jason E. Dunn, a vice president at Southeastern, said Thursday that “competitors and bears” have highlighted Sun’s low stock price, while ignoring its cash, the value of Sun’s technology assets and its chances to cut costs. “We are seeking the best ways to capitalize on Sun’s large intrinsic value,” Mr. Dunn said.

Sun’s woes stem in part from declining sales of servers that run the Unix operating system — a long-shrinking market dominated by Sun, I.B.M. and Hewlett-Packard. Sun has poured billions of dollars into new products meant to offset these losses, but many of the products are a year or more late to market.

In addition, Sun has tried to increase the adoption of its software by giving away prized products under an open-source model. Sun argues that mass distribution of its software will lead to more hardware and services revenue, although results have been lackluster so far.

Last November, Sun tried to polish its image through a one-for-four reverse stock split. Over the last 11 months, Sun shares have tumbled to pre-split prices.

Sun remains a cash machine, however, taking in more than $1 billion during its last fiscal year. While the company has used some of this money for large share repurchases, it has also made some questionable acquisitions, including the $4.1 billion purchase of StorageTek, a lumbering maker of tape storage units, which was included in Thursday’s charge.

Morale inside Sun, long a favored bastion of top engineers, is sagging, according to current and former employees. The company has endured a number of large layoffs in recent years, although the company still employs about 33,000 people.

Mr. Schwartz suggested that more cuts are on the way. Sun understands “the need to balance our costs in light of the new economic reality,” he said.

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